401k Pension Plan Choices for Small Businesses

Thinking about starting a 401(k) retirement plan for your small business employees and for yourself? There are several types of plans to choose from. Here’s an overview of options for businesses with employees and for one-person businesses. 

As a small business owner, you may decide to start a 401(k) plan for any number of reasons, including the fact that a quality 401(k) plan can be a powerful recruiting tool. Every business wants to attract the best and the brightest. Showing potential employees you have a concern about their future retirement can be a big plus.

A well-constructed 401(k) plan can also provide an incentive for talented employees to stay. Once you’ve invested the time and expense required to train a quality employee, keeping them on board is in your financial best interest.

Finally, there are the benefits you realize from taking a tax deduction for your contributions to employees’ accounts.

Whatever your reasons, establishing a 401(k) plan involves certain required basic steps. Step one is choosing which type of 401(k) plan to offer.

Choosing a Plan

The Internal Revenue Service provides guidance on the various types of 401(k) plans available to small businesses. Read IRS Publication 560 before making the choice to open any one of these plans:

Traditional 401(k) Plan

A traditional 401(k) defined plan allows employees to use pretax money to contribute. This means the employee pays no income taxes on the money before it goes into the 401(k) account.

As the employer, depending on the plan design, you have the option to contribute on behalf of participating employees. This is generally referred to as the employer match.

Your contributions can be subject to vesting over time so employees are encouraged to stay in the plan to avoid forfeiture of some part of your matching contributions.

Your 401(k) plan is subject to annual tests to ensure it meets IRS nondiscrimination requirements, including discrimination in favor of highly compensated individuals.

Solo Participant 401(k) Plan

The solo participant plan is also known as the one-participant or Uni-k plan. It’s not a separate type of plan but rather a traditional plan designed for a business owner with no employees (or a sole owner with family members). The rules for this plan are the same as those for a traditional 401(k) plan.

Safe Harbor 401(k) Plan

A safe harbor 401(k) plan is much like a traditional 401(k) plan. Your contributions as the employer, however, must be considered fully vested when made. These plans are not subject to the same nondiscrimination tests as the traditional 401(k) plans.

Safe harbor and traditional plans are appropriate for any size business. They can also be combined with many of the other retirement plans.

SIMPLE 401(k) Plan

A SIMPLE 401(k) plan is attractive because, as with a safe harbor 401(k) plan, the annual nondiscrimination tests do not apply. Also, as with the safe harbor 401(k), your employer contributions must be considered fully vested when you make them.

This plan is available to you if you have 100 or fewer employees and they each received $5,000 or more in the previous calendar year. Your employees in a SIMPLE 401(k) plan are not allowed to participate in any other qualified retirement plan.

To learn more about all three types of 401(k) plans, refer to Publication 4222, 401(k) Plans for Small Businesses.

Roth 401 (k) Allowance

Under IRS rules, 401(k) plans allow your employees to designate some or all of their elective deferrals as “Roth elective deferrals.” These deferrals generally follow the same rules as Roth IRAs. Page 18 of IRS Publication 560 discusses the Roth allowance.

Additional Basic Rules

Conditions of participation – A 401(k) plan cannot require that an employee be with the company for more than one year in order to be eligible to participate.

Automatic enrollment – A 401(k) plan can have an automatic enrollment feature. The employee, however, must be able to choose not to have his or her wages reduced and select the percentage of their pay to contribute.

Elective deferral limits – The IRS limits the amount that a participant can defer on a pre-tax basis each year.

Matching contributions – If the 401(k) plan contract allows, you as the employer can make matching contributions for any employee who contributes to their 401(k) plan account.

Other employer contributions – If the plan allows, you can make additional contributions on top of the employee match for participants, including those who don’t want to contribute elective deferrals to the 401(k) plan.

Employee compensation limit – $345,000 (for 2024) of an employee’s compensation can be the basis for determining contributions.

Vesting – By law, your employees are considered fully vested in any elective deferrals they make. Your plan may provide for vesting over several years for matching or other contributions you make.

Which should you choose?

Each of these plans is designed for a different type of business making a specific recommendation impossible. If you are unsure, a tax attorney vs CPA, attorney, or accountant can help. Also, ask other small business owners for their experiences with the plans.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.